Fitch Ratings has assigned Royal Bank of Canada's (RBC; rated 'AA/F1+', Outlook Stable) USD2.5 billion series CB8 mortgage covered bonds an 'AAA' rating. The Rating Outlook is Stable. In addition, the CAD-equivalent 9.5 billion covered bonds outstanding under the program are affirmed at 'AAA'/Outlook Stable. The covered bonds are guaranteed by RBC Covered Bond Guarantor LP, a limited liability partnership established for the program with restricted permitted activities.
The rating is based on RBC's long-term Issuer Default Rating (IDR) of 'AA', the Discontinuity Cap (D-Cap) of 3 (moderate-high risk) and the program's contractual asset percentage (AP) of 91.1%.
In terms of sensitivity of the covered bonds' rating, the 'AAA' rating would be expected to be maintained, - all else being equal - even if one of the following occurred: (i) the IDR was downgraded by up to three notches to 'A' or (ii) the D-Cap fell by three categories to 0 (full discontinuity).
The program's contractual AP is in line with Fitch's 'AAA' breakeven AP of 91.1%. As overcollateralization above the contractually committed amount is secured by a demand loan back to the issuer, the agency takes only the contractually committed AP into account in its analysis.
The D-Cap of 3 (moderate-high risk) is driven by the weakest risk assessment of the five D-Cap components, which is for the systemic alternative management component in line with all other Canadian programs. A moderate risk assessment has been assigned to the liquidity gap and systemic risk component which reflects the adequate protection from payment discontinuity in the form of a 12 month extendable maturity on the covered bonds. The assessment also takes into account RBC's intention to amend the terms of repayment of the demand loan by Dec. 31, 2012. The change will provide for the demand loan to be repaid in kind unless the cover assets can be sold at par or higher, eliminating the added stress on liquidity if the loan were otherwise to be paid in cash. If the program documents are not amended with the revised language by Dec. 31, 2012, then Fitch will reassess the program, which could potentially lead to a lower D-Cap (indicating a greater link between the rating of the covered bonds and the issuer rating) and a lower 'AAA' breakeven AP.
All of the other D-Cap components are assessed as moderate risk from a discontinuity point of view. For more details, reference 'Fitch Places BACBI's Covered Bonds on Negative Watch; Assigns US and Canadian D-Caps & Outlooks' published on Sept. 12, 2012.
As of July 31, 2012, the cover pool consisted of 112,683 first-lien residential mortgage loans totaling CAD14.9 billion with a weighted-average (WA) original loan to value (LTV) of 73.1% (as calculated by Fitch). In an 'AAA' scenario, Fitch has calculated a cumulative weighted-average frequency of foreclosure (WAFF) of 13.8% and a weighted-average recovery rate (WARR) of 48.7%. In the absence of published criteria for determining expected credit losses for cover pools for new issuances of covered bonds, Fitch's WAFF and WARR were derived from reviewing the loan level pool data under the agency's Resilogic mortgage loss model in conjunction with an analysis of historical default and loss data provided by the issuer and other institutions. Fitch is in the process of developing a Canadian residential mortgage default and loss model.
The weighted average life (WAL) of the assets in the cover pool is approximately 2.5 years, compared to the WAL of 3.8 years for the covered bonds. Interest rate and currency risks on the covered bonds are hedged via swaps with RBC as counterparty with collateral posting and replacement provisions in line with Fitch criteria.
The rating action also incorporates a revision of refinancing spread assumptions, which are used to estimate the stressed sale price for the cover pool that an alternative manager would liquidate in the aftermath of an issuer default. The net present value (NPV) of cover pools is determined by discounting the value of the assets at a rate reflective of the revised refinancing spreads. The NPV of the assets is now lower than the previous assumptions given the revised refinancing spread assumption approach.
The Fitch AP in line with the covered bond rating will be affected, among others, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuances. Therefore, it cannot be assumed to remain stable over time.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Covered Bonds Rating Criteria' (Sept. 10, 2012);
--'Covered Bonds Counterparty Criteria' (July 25, 2012);
--'Resilogic Mortgage Loss Criteria' (Aug. 10, 2012).
Applicable Criteria and Related Research:
Covered Bonds Rating Criteria - Amended
Covered Bonds Counterparty Criteria
ResiLogic - Mortgage Loss Criteria
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